Getting off the carousel

VAT fraud sounds like something that builders or plumbers are doing when they offer a discount for cash. In fact it is a sophisticated criminal industry that preys upon the smooth operation of the tax system, and has cost this country billions of pounds in recent years. The fraud works by exploiting the system of up-front refunds of taxes such as VAT charged on small, high-value items such as mobile phones, which can be imported free of tax from another EU member state. The amounts involved are scandalous, but the length of time taken in effectively tackling it even more so.

This newspaper revealed the multibillion-pound scale of the elaborate schemes - sometimes known as "carousel fraud" because of the circular nature of the transactions - in early 2003, while what was then known as Customs & Excise (now known as HM Revenue & Customs) was seriously concerned at least a year previously. Yet the size of the fraud continues to spiral upwards, as we have reported recently, with 9,000 criminals said to be involved and an unknown amount lost in making the fraudulent refunds, although the total lost is expected to run into several billions of pounds. The fraud has not only distorted the UK's trade statistics, to an extent that the Bank of England said it was extremely difficult to measure the true position, but also skewed the Treasury's budget forecasts for income from VAT receipts.

HMRC has thrown additional resources at the problem, which are now bearing fruit. The best result has been a recent raid involving hundreds of customs officers that led to 22 arrests and made use of European-wide cooperation. This is clearly the way forward: carousel fraud is an EU issue. According to the EU's tax commissioner, the schemes may cost member states a combined €50bn a year in lost revenue. It needs to be tackled at a European level, in terms of policy and policing.

Improving cooperation between national police forces and tax authorities is the easy part. Less obvious is the policy response to deprive the fraud of oxygen. The UK recently fought for and won the ability to change the refund method on the most popular goods used by the fraudsters. That may just cause the criminals to switch targets. The best response is also the least palatable: a degree of tax harmonisation that allows goods to be taxed at their EU place of origin rather at point of sale. It would solve the problem at a stroke, and be a logical extension of the single market. But current political realities means that Europe's citizens and businesses will continue to be short-changed.